Types of Cost Estimates
Auditors are likely to encounter life cycle cost estimates (LCCEs), which includes program office estimates and independent cost estimates. Auditors may also see other types of cost estimates, such as independent cost assessments (ICAs), budget estimates, rough order of magnitude (ROM) estimates, estimates-at-completion (EACs), and independent government cost estimates (IGCEs).
Life Cycle Cost Estimate
A life cycle cost estimate (LCCE) provides a structured accounting of all labor, material, and other efforts required to develop, produce, operate and maintain, and dispose of a program. The development of a life cycle cost estimate entails identifying and estimating all cost elements that pertain to the program from initial concept all the way through each phase in the program’s duration. The program LCCE encompasses all past (or sunk), present, and future costs for every aspect of the program, regardless of funding source.
Life cycle cost estimating informs decision making, especially in the early planning and formulation of an acquisition program. Design trade-off studies conducted in this period can be evaluated on the basis of cost, as well as on a performance and technical basis. A life cycle cost estimate can support budgetary decisions, key decision points, milestone reviews, and investment decisions.
The LCCE should become the program’s budget baseline. Using the LCCE to determine the budget helps to ensure that all costs are fully accounted for so that resources are adequate to support the program.
We will generally use the terms development, production, operations and maintenance, and disposal to describe the phases of a program life cycle. However, federal agencies may use different terminology and definitions for the phases of a program life cycle. OMB’s Capital Programming Guide broadly defines the program acquisition life cycle as including concept analysis, technology definition, requirements planning, acquisition, and operations and maintenance.7 DOD identifies four phases: research and development, investment, operating and support, and disposal.8 Other agencies may refer to the research and development and investment phases as the development, modernization, and enhancement phase and include in them acquisition planning and funding. Additionally, agencies may refer to operations and support as “steady state” and include them in operations and maintenance activities.
Regardless of the terminology used to describe the various phases, LCCEs provide a wealth of information about how much programs are expected to cost over time because they include all program costs. Information from LCCEs can be displayed graphically (as shown in figure 2 below) to show what funding is needed at a particular time and when the program is expected to move from one phase to another.
Figure 2: A Representative Life Cycle Cost Estimate for a System
Figure 2 illustrates a notional profile of costs over time for a program from its beginning through disposal using DOD life cycle phase terminology. Profiles for programs can vary significantly by system. For example, space systems must invest heavily in research and development because once a system is launched into space it cannot be retrieved for maintenance. Other systems such as aircraft, ships, and information technology systems typically incur operating and support costs that are large in comparison to research and development and investment costs. Such operating and support costs are large because the systems can be retrieved and maintained and therefore require ongoing support and recurring broad-based training for large user populations. Thus, having full life cycle costs is important for successfully planning program resource requirements and making wise decisions.
Table 1 describes the two types of life cycle cost estimates and the level of effort needed to develop them.
Table 1: Life Cycle Cost Estimates
| Estimate type | Level of effort and Scope | Description |
|---|---|---|
| Program office estimate (POE) | Requires a large team, may take many months to accomplish, and addresses the full life cycle | A POE is the responsibility of the program manager. It should cover the entire life of the program and be phased by fiscal year for all years from initiation of the program to the disposal phase. POEs are used to prepare the resource requirements for translation into programming and budgeting documentation and requests. |
| Independent cost estimate (ICE) | Usually requires a large team, may take many months to accomplish, and usually addresses the full life cycle | An ICE, conducted by an organization independent of the acquisition chain of command, is based on the same detailed technical and programmatic information used to make the baseline estimate’usually the POE. ICEs are developed to support new programs or conversion, activation, modernization, or service life extensions and to support milestone decisions for programs. ICEs are used primarily to validate program office estimates and are reconciled with them. Because the team performing the ICE is independent, the ICE provides an unbiased test of whether the program office cost estimate is reasonable. It is also used to identify risks related to budget shortfalls or excesses. |
Source: GAO, DOD, NIH, OMB, and ICEAA | GAO-20-195G
Other Types of Cost Estimates
Other types of cost estimates also support agency and program decisions. These types of estimates may not include the entire life cycle of the program. Table 2 looks more closely at these types of cost estimates.
Table 2: Other Types of Cost Estimates
| Estimate type | Level of effort and Scope | Description |
|---|---|---|
| Budget estimate | Requires a large team, may take many months to accomplish, and usually covers only a portion of the LCCE | The budget estimate should be based on the POE or another LCCE such as an ICE. The budget estimate typically covers only the upcoming few years and not the entire life cycle.a It must be translated to budget yearb dollars with the application of inflation and time-phasing, and should identify the appropriation type(s) and account for any funding policies associated with those appropriations. |
| Rough order of magnitude (ROM) estimate | May be done by a small group or one person; can be done in hours, days, or weeks; and may cover only a portion of the LCCE | Similar to the ‘conceptual estimate’ defined by OMB, a ROM is developed when a quick estimate is needed and few details are available.c Usually based on historical information, it is typically developed to support what-if analyses and can be developed for a particular phase or portion of an estimate or the entire cost estimate, depending on available data. It is helpful for examining differences in high-level alternatives to see which are the most feasible. Because it is developed from limited data and in a short time, a rough order of magnitude analysis should never be considered a budget-quality cost estimate. |
| Independent cost assessment (ICA) | Requires a small group; may take months to accomplish, depending on how much of the LCCE is being reviewed; usually does not address the program’s entire life cycle | An ICA is a non-advocate’s evaluation of a cost estimate’s quality and accuracy, looking specifically at a program’s technical approach, risk, and acquisition strategy to ensure that the program’s cost estimate captures all requirements. Typically requested by a program manager, outside source, or required by agency policy, it may be used to determine whether the cost estimate reflects the program of record. It is not as formal as an ICE and does not have to be performed by an organization independent of the acquisition chain of command, although it usually is. |
| Independent government cost estimate (IGCE) | Requires a small group, may take months to accomplish, and covers only the portion of the LCCE phase under contract | An IGCE is conducted for multiple purposes. First, it helps the government to determine budgets for notional contracting actions. Secondly, it serves as a comparison point to check the reasonableness and realism of a contractor’s cost proposal. Finally, its details support the contracting officer through the negotiation and award process. IGCEs are helpful to programs in assessing the feasibility of individual emergent tasks to determine if the associated costs are realistic and reasonable. |
| Estimate at completion (EAC) | Requires nominal effort once earned value management (EVM) data are on hand and have been determined to be reliable; covers only the portion of the LCCE phase under contract. Bottom-up EAC development requires additional effort. | An EAC is an assessment of the cost to complete authorized work based on a contractor’s historical EVM performance. One method of developing an EAC uses various EVM metrics to forecast the expected final cost. A second method, called a bottom-up or comprehensive EAC, involves a detailed assessment of the effort remaining to estimate cost. |
aOMB states that the budget focuses primarily on the upcoming fiscal year; however, it includes data from the most recently completed year, the current year, and nine years following the budget year.
bThroughout this guide we use “budget year” to mean dollars that include the effects of inflation. “Budget year” dollars are often referred to as “then-year” dollars by cost estimators. We use the term “base year” to mean dollars that are expressed in the value of a specific year and do not include the effects of inflation. “Base year” dollars are often referred to as “constant year” dollars. See chapter 9 for more information.
cOffice of Management and Budget, Circular A-11 (Washington, D.C.: December 2019).
Additionally, auditors may encounter various analyses which rely upon life cycle cost estimates or other types of cost estimates. These may include analysis of alternatives (AOAs), cost effectiveness analysis, and benefit-cost analysis.
Analyses of alternatives: The AOA process is an analytical study conducted to compare the operational effectiveness, cost, and risks of a number of potential alternatives to address valid needs and shortfalls in operational capability. This process helps ensure that the best alternative that satisfies the mission need is chosen on the basis of the selection criteria, such as safety, cost, or schedule. GAO has identified 22 best practices for an AOA process that are detailed in appendix XI.
Cost effectiveness analysis: Cost effectiveness analysis is a systematic quantitative method for comparing the costs of alternative means of achieving the same stream of benefits or a given objective. A program is cost effective if, on the basis of a life cycle cost analysis of competing alternatives, it is determined to have the lowest costs expressed in present value terms for a given amount of benefits. Cost effectiveness analysis is appropriate when the benefits from competing alternatives are the same or where a policy decision has been made that the benefits be provided.
Benefit-cost analysis: Benefit-cost analysis is a systematic quantitative method of assessing the desirability of government projects or policies when it is important to take a long view of future effects and a broad view of possible side effects. Benefit-cost analyses should include comprehensive estimates of the expected benefits and costs to society based on established definitions and practices for program and policy evaluation.
Office of Management and Budget, Captial Programming Guide: Supplemental to Circular A-11, Part 7, Preparation, Submission, and Execution of the Budget (Washington D.C.: December 2019)↩︎
Department of Defense, Office of Secretary of Defense - Cost Analysis and Program Evaluation, Operating and Support Cost Estimating Guide (Washington D.C.: March 2014), 2-3 to 2-4↩︎